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3 Reasons This Stock Market Surge Is About to Make Its Final Gasp

3 Reasons This Stock Market Surge Is About to Make Its Final Gasp
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  • As stimulus wears off in July, the stock market might react to weakening consumer health.
  • Q2 earnings season will finally give investors concrete data to trade on.
  • At some point, investors will start to worry about a Democrat sweep in the November elections.

Since the stock market crashed in mid-March, shares have done (almost) nothing but climb. The epic rally is based largely on the belief that the Federal Reserve is building a bridge to the greener pastures of 2021.

But with the S&P 500 rapidly approaching its February highs, even some Wall Street bulls are starting to worry about a prolonged stock market correction.

The S&P 500 has nearly erased all of its pandemic-related losses. | Source: Yahoo Finance

So far, the rally has proven virtually unsinkable, but a perfect storm of uncertainty in July could be the straw that breaks the camel’s back.

1. Stock Market-Boosting Stimulus Will Start to Fade

The U.S. consumer has been the epicenter of pandemic stimulus payments. The American economy is heavily dependent on consumer spending, so lawmakers are focused on keeping consumers strong.

The belief that U.S. consumers will return to spending as they did in February is a huge part of why the stock market has been able to rally. 

Consumer spending makes up nearly 70% of the U.S. economy, so lawmakers are focused on keeping that metric from continuing to decline. | Source: Trading Economics

Next month, we’ll find out if that’s true.

Much of the government’s support will start to evaporate in July, and markets will get their first look at the true health of U.S. consumers.

The government’s additional $600 per-week unemployment benefits run out at the end of July. Barring an extension, this will leave a great many people struggling with a ~$2,400 gap in their monthly income.

To make matters worse, unemployment claims may spike just as benefits recede to ordinary levels.

Non-farm payrolls data painted a rosy picture of the labor market, but come July, some of those gains could be erased. | Source: Barrons

The government’s Paycheck Protection Program loans afforded businesses enough funds to cover 2.5 months of payroll. Companies that were using the money to pay their staff are going to start running out of cash at some point in July.

That could usher in a flood of new unemployment claims as businesses struggle with reduced demand and social distancing rules that hurt profits.

2. Earnings Season Isn’t Going to Impress

Perhaps the greatest risk to the U.S. stock market is earnings season.

In July, companies will start to report their second-quarter results, and investors will get their first glimpse at how they’re planning to deal with the pandemic fallout.

In Q1, most firms pulled their guidance or revised it markedly lower— all in all, it was a non-event as investors agreed that the Q1 figures essentially didn’t matter.

The S&P 500 has risen despite a marked decline in earnings estimates, making it an expensive market. |Source: FactSet

But now that there’s a bit more clarity into how the pandemic will progress, investors will, for the first time in months, have the ability to price stocks based on future earnings.

TD Ameritrade Chief Market Strategist JJ Kinahan said that could be a recipe for disaster:

My fear is that the reality of when we start getting real earnings. When we start getting back to earnings that mean something, that you can trade off of, the reality of the earnings may not keep up with the great optimism that we’ve seen.

The S&P 500 is already at its most expensive level relative to future earnings in nearly two decades.

Earnings season will either confirm that 2021 is going to be the bumper year investors have priced in, or it will force them to face the harsh reality that the pandemic won’t be so easy to brush off. 

3. Election Season Is Looking Worse and Worse for Wall Street

Election season will start to have an impact on the market if Biden and the Democrats are favored to score a November sweep. | Source: AP Photo / Marcio Jose Sanchez

Investors haven’t paid too much attention to the trajectory of the November elections, but next month, they’re likely to start paying attention.

While everyone knows Joe Biden is the Democrats’ candidate, July’s Democratic National Convention will make it official. It will likely be the start of more aggressive campaigning, and the election will dominate the headlines as public interest in virus coverage continues to wane.

That could be bad for markets if Joe Biden remains in the lead. There’s a chance Democrats will secure control of both the executive and legislative branches of the U.S. federal government, making it much easier to pass progressive policies.

Top of the priority list is likely to repeal Donald Trump’s corporate tax breaks— a move that would be bad for the stock market no matter how you slice it. 

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com. Unless otherwise noted, the author has no position in any of the stocks mentioned.

This article was edited by Josiah Wilmoth for CCN.com.

Last modified: June 12, 2020 4:55 PM UTC

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